This isn't E-wave but here is a macro view of what I feel is happening.....
I honestly believe the Fed has our best interests at heart and though I along with many others post how irresponsible they are with their lax monetary policies, I believe they are doing so because the other option is just too damaging to the economy. I mean we all know that “fair value” by historical norms would mean that the market would have to fall at least 50% and more likely 75% or more. Measuring by PE ratio, PEG ratio, Gold to DOW ratio, Looong term channels, debt loads etc all point to much much lower prices. However if they allowed the bubble to fully deflate, it would cause disastrous implications to the economy and could institute a shock to the economy that could take decades to recover from.
Private ownership in stocks either directly, through 401Ks, IRAs and even remotely through insurance policies is at all time highs by a far margin. Allowing historically normal and realistic valuations to return would create at least 2 generations of Americans without retirement funds that would require a full reliance on a broken Social Security and Medicare program to provide for. It would leave a generation of college kids without private funds to pay for tuition leaving a void of qualified workers for the next few decades with state budgets unable to pick up scholarship needs. Home loan and Bank card defaults would collapse the banks and thus the nations financing arm. Basically, the USA would grind to a screeching halt and would likely drag the rest of the world down with it. I mean, I am talking total meltdown and this is not a bearish doomsday scenario but a real no kidding Fundamental reality. State budgets can’t pickup the slack, the Federal level can’t pay for this nation’s needs for that long and there are no private savings to fall back on. I see no way we could let the market go down to realistic fair values without causing epic proportional damage.
This leaves a very smart Federal Reserve with a problem. They know they have a bubble on their hands but at the same time they are staring down the deflationary double barrel. They have only two choices and which is the lesser evil? They have been very very good at slowly deflating the bubble this far but now are seeing real danger signs of deflation taking too hard a hold on things. This is a result of misappropriation of invested funds during the internet bubble. Private investors pushed money at pipe dreams while neglecting real companies thus leaving the real industries with a shortage of funds and forcing them to get financing through bank loans thus creating a real debt burden that is still overhanging them. Cost cutting is their only release thus the exodus of jobs to cheaper areas where taxes are lower and workers are cheap. I don’t see this trend changing until debt is under control.
Anyway, back to the Fed. Greenspan et al knows we are in a pickle. He would have loved to let the markets continue to deflate but deflation and over capacity started getting too strong a toe hold so he had to open the spigots again and pray that those dollars would pay down debt and get the economy going again. He was probably praying hard and I mean praying the stock market would have learned it’s lesson from the bubble popping just a few years ago but instead was met with an investing generation that only knew buy the dip and play the Momentum stocks and thus we are once again getting stupid in the market.
I just posted Bernadake’s speech on the Marketswing/ References/Fed Thread and I say his speech is a must read as I feel he makes some good points and spells out the gloomy scenario fairly well though he is forced to try to mitigate it to avoid a panic by throwing in a few side bars I doubt the Fed really believes like we don’t have a debt problem etc.
What we are faced with now is a loose Fed that has it’s back against the wall. This is 1999 all over again. We have an irrational stock market but on the other side we have a deflating economy with high over capacity, high debt load and thus there is no choice but to keep the monetary spigots wide open. In Economic 101, it is taught that budget surpluses are deflationary and Federal Budget deficits are inflationary. I think it is no accident that Bush has put us in a deep Budget deficit mode as he is working in concert with the Fed to try to get the industrial machine working again. The truth hurts and the American public are a bunch of morons. When we had record low unemployment and were in a bubble blowoff with a real threat of hyper inflating, the only way to get control of inflation besides rate increases was to get unemployment up to the normal 6% range. It isn’t politically correct but 6% unemployment is ideal. Americans don’t understand that but it is and now we are near there. If they can get it stabilized there, we might be in good shape. The problem of course is if we overshoot too much like the Fed did to stop the bubble inflation and over shot interest rates. I doubt the Fed wanted to raise rates so much but the market kept saying that it was a “new economy” and keep buying business plan on a Starbucks napkin companies that would never earn a penny in profits so he had to keep raising until he got Wall Street’s attention. Unfortunately the side affect was real industry got strangled on their debt and thus the pickle we are in now.
Greenspan is a maestro and I feel he knows what he doing though he is facing impossible odds here. He liquefies the economy to get it going and most of the cash goes to dumb investments like Mo Mo stocks. He is facing a President who is the son of the guy he screwed over in 90. He knows much more than I do but I feel he is in a position where his only choice is to flood money like no tomorrow and then raise margin requirements and come right out and give one of his irrational exuberance speeches. I know I am probably dreaming but oh well.
That said, the other probability, and the most likely one is he ignores the market and hopes he or someone else can deal with it later. Right now he is focused on the big picture global and American Economy and the market is a side distraction. At the same time, the market is the economy thus he is now incorporating it into his recovery plan. I kept posting the Fed economic reports on the main thread hoping to see someone comment on them but I guess no one reads them. For the first time last week, the DOW Jones and Wilshire 5000 are charted on the weekly economic report. Now tell me he isn’t targeting the markets!!!!!
What does all this mean and what does this outlook mean for us? I think we are going to hyper inflate money supply and everything will go up. We will continue to see deflation per Bernadake’s speech in pricing power and profits for another year while costs for life’s necessities squeeze the public’s spending power. Job layoffs will continue as industry tries to get costs and debt under control. Meanwhile the markets will continue to diverge from reality due to the over abundance of money and no where else to put it. Industries already have too much debt so they don’t want it. At some point in the future, as in far down future like 2005-2006, we will either see a turn around in the economy as debt becomes manageable, risks are hedged and all the over capacity is finally absorbed via normal population growth and company mergers and plant shutdowns …OR… unemployment impact, refinancing limits and debt burden will finally crush the recovery effort and the whole thing will implode under it’s own weight. Basically the Famous Greenspan interview where he attempts to liquefy the Kondrapov cycle into a delay that creates an even bigger mess down the road comes to reality and the world ceases to exist in a way we recognize. Total financial lockup. There are various other side scenarios I see as big possibilities such as financial shocks due to Greenspan dying or retiring, Asian Bank collapses etc but they are mainly divergences of the bigger two scenarios and are more of sparks to get one ball rolling or the other.
In Bernadake’s speech, he points out that we will have no way of knowing if we are recovering or not until at least the END of 2004. They will have to keep the monetary spigot wide open and wait and see. This means we are facing 18 months of dollar devaluation, debt roll overs, and everything priced in cheaper dollars until we finally get to see if real price adjusted dollar profits rise or not for corporations. Devalued dollars also mean stock prices will climb at the rate the of devaluation adding yet another unknown into out pricing models.
Mid Term it all boils down to two factors. Monetary creation and debt overhang. These two forces are playing tug of war. The debt is causing an exodus of jobs to foreign shores searching for cheaper labor and favorable tax rates. The monetary creation is trying to liquefy that debt into cheaper dollars to pay it off with and provide liquidity to avoid a financial lockup. The side effect is a market that is climbing due to too much money and not any form of Fundamentals. A responsible Fed would normally want to raise margin to control this undesirable side affect but it appears that the Fed is going to try and use the Markets to help liquefy the deflation away and spur inflation. At the end of this grand experiment we will either see a recovery or a failure of the plan and a really nasty outcome I don’t even want to think about. Of course smaller nasty outcomes are an overshoot of hyper inflation, if the plan works a market that is still grotesquelly over valued to tweek down but by then it will be someone else's problem.
One thing is certain, economic history is being written and we are in the middle of it. Can’t wait to buy the college Economics book and see how it all played out someday.
Good Luck,
Lee |
